Essays on economic crisis, decoding dominant ideologies and creating a better world

Nationalizing banks works for the short term; why not permanently?

U.S. President Barack Obama famously sneered that “Sweden had like five banks” when dismissing the idea of a government takeover of the U.S. banks that brought down the world economy. He did so despite acknowledging that Sweden had swiftly overcome its early 1990s financial crisis by taking over its largest banks.

The president was channeling a prevailing mythology within the United States — namely, that Sweden is a socialist country. Socialist! Run, run for your life! Therefore anything Swedish must automatically be so horrifying that we must not allow any thoughts about it to enter our minds for even a fleeting second.

Sweden is actually a capitalist country (albeit one with social-welfare policies to ease capitalism’s harshness), and the solution that it used to put its big banks back on their feet was well within the confines of capitalism. Actually, Sweden did not go as far as its neighbor, Norway, which also nationalized big banks to overcome its own early 1990s financial crisis.

Sweden and Norway made the banks — and their executives, directors and shareholders — pay for the crisis they caused, rather than making their taxpayers pay for it. Unsurprisingly, deregulation and speculation were behind the Scandinavian meltdowns.

Rather than following the Scandinavian model, the U.S. government shoveled trillions of dollars into its big banks following the 2008 financial meltdown without forcing any changes in banking practices or management. Or much of anything — it was the world’s biggest blank check. As a result, the banks are bigger than ever, the bonuses executives give themselves are as big as ever, not a single financier has been brought to justice, the financial crisis goes on and we remain at the mercy of the financial industry.

Sweden and Norway may not be large countries, but, despite President Obama’s sneering comment, they are not tiny, either. Sweden, in fact, has more than 100 banks. What Sweden and Norway have in common with the U.S. is that their banking industries are dominated by a few large banks. The four biggest banks in the U.S. in the first months of the economic crisis — JP Morgan Chase, Citigroup, Bank of America and Wells Fargo — accounted for almost two-thirds of the assets of U.S. commercial banks. Thus, as Keynesian economist Paul Krugman once noted in his blog, “as far as this discussion is concerned, we’ve got, like, four banks.”

Norway wipes out shareholders, fires bankers

Because Norway took stronger measures than Sweden, let’s start the comparison there. Four banks accounted for almost 60 percent of bank lending in Norway on the eve of its crisis, and three of them would get themselves into deep trouble. Norwegian banking had been tightly regulated, but in the mid-1980s a series of measures lifted most regulation of banking and housing and eliminated capital controls, sparking a wave of speculation in the forms of a boom in new lending and a real estate bubble. Household consumption rose dramatically, based on debt incurred via the new loose credit, and bank managers began to be paid based on growth in lending.

A simultaneous drop in oil prices (Norway is dependent on oil exports) led to a devaluation of Norway’s currency (then on a fixed exchange rate) and a trade deficit. As the real estate bubble began to burst, several of Norway’s small banks failed, a problem that could initially be contained because the Norwegian government had continued to enforce a requirement that all of the country’s banks contribute to guarantee funds; these funds covered depositors. But continued financial turbulence caused two of the country’s four biggest banks to fail and a third to be on the brink of failure.

The guarantee funds had been depleted due to the failures of the small banks, and private investors were unwilling to invest with their own capital. The Norwegian parliament stepped in and injected capital directly into the banks, taking ownership and enforcing several conditions, including these:

Existing share capital would be written down to fully cover losses — shareholders would be wiped out.

Managers and members of the board of directors would be fired.

Banks must reduce operating costs and downsize some activities.

The banks were now owned by the government, which acted like an owner. But that ownership was exercised not directly by the government, but through a special agency created for the purpose of managing the taken-over banks and staffed by specialists to avoid political interference. Eventually, the Norwegian government sold all the shares of two banks and retained a minority interest in the third to block a foreign takeover of what is now the only one of the major banks to be based in Norway. By 2001, the government had earned a net gain for its troubles.

This program specifically avoided guaranteeing bank losses. It was designed so that taxpayers would not assume the risk, which would only encourage more risk-taking by bankers. In a report on these events, the deputy governor of Norges Bank (Norway’s central bank) wrote:

“If the government injects new capital into a crisis-stricken bank, it is important that the value of the existing shares are written down as far as necessary to cover the losses. Otherwise, the government would implicitly be using taxpayers’ money to subsidize shareholders of a failed or failing bank and would give rise to serious moral hazard problems.”

Sweden forces banks to write down losses

The Swedish government did not impose conditions as stringent as those imposed in Norway, but did make shareholders absorb some of the pain and nationalized the most troubled big banks. Financial deregulation in the 1980s led to reckless lending and a real estate bubble in Sweden. When the bubble burst in 1991 and 1992, Sweden fell into a recession and unemployment quintupled in three years.

The Swedish government declared it would guarantee all deposits in all banks, committed itself to recapitalizing banks in trouble and said any bank seeking government money would have to first write down its losses. Sweden did seize the most troubled big banks, although in one case (in which it already owned a majority interest) the government paid the full price for acquired shares rather than wiping out shareholders.

Sweden then set up two “bad banks” and transferred non-performing loans made by the taken-over banks to them. Privately owned banks would have forced immediate bankruptcies to shut down and seize the assets of the small and midsize businesses that had taken out these loans they could not repay. In contrast, the government “bad banks” took control of the businesses and worked to stabilize them for eventual re-sale, the proceeds of which would recover the bad loans.

For the most part, however, Sweden forced shareholders out of failed banks and imposed stringent risk-management measures and overhead reductions. But by issuing a blanket guarantee of all bank loans, the government benefited shareholders of the banks that had not been taken over, a contrast to Norway. But, similar to its neighbor, Swedish taxpayers benefited when the government later sold its shares in taken-over banks.

U.S. rewards bankers for destroying economy

In contrast, the U.S. government, during both the Bush II/Cheney and Obama administrations, handed out vast sums of money with no strings attached. Wall Street executives, on loan to the government, “advised” the presidents that unconditional and unlimited bailouts to their companies could be the only solution. As a result, financiers remain free to speculate at will and give themselves vastly bloated salaries and bonuses. A good example is provided by a Dartmouth University professor, B. Epsen Eckbo, who wrote during the first months of the economic meltdown:

“It’s a zero-sum game: if the tax-payer doesn’t insist on the best possible deal, some other party to the bailout will reap benefits at the tax-payer’s expense. A clear case in point is the $8 per share windfall to shareholders of Bear Stearns, when the government debt guarantee of that firm caused JPMorgan to raise its takeover bid from $2 to $10. This type of shareholder windfall, which we also saw in Sweden as the stock market responded to the government’s blanket debt guarantee, would have been avoided had the government taken an equity stake in the bailed-out bank.”

The Obama administration did take an equity stake when it bailed out the automobile manufacturers General Motors and Chrysler, with the potential to earn a profit from doing so, while saving jobs directly and indirectly associated with the two companies.

Why not do the same with big banks? Or, why don’t we not be timid and go further: Why not eliminate financial speculation through public ownership of banks? Norway and Sweden did solve their banking crises, but not underlying economic weaknesses — Norway remains dependent on high oil prices and Swedish unemployment, while well below its peak, remains far above what it was before the early 1990s crisis.

In fact, there is a successful example of state-owned banking inside the United States. It is the Bank of North Dakota, wholly owned since 1919 by that state’s government. The Bank of North Dakota operates as a commercial bank, taking deposits and making loans, and also is where the state government deposits its revenue.

The state’s tax money, therefore, is invested in local infrastructure projects rather than being used for speculation by national banks as other states’ revenues are. So successful is the bank that it has given $300 million in profits to the state government in the past ten years.

North Dakota is the only one of the 50 U.S. states to have its own bank, and while the local economy is currently strong due to an oil and gas boom, it certainly serves as an example. Why not replicate this success elsewhere?

As long as we are asking questions, why should something so critical to a modern economy as finance and banking be in private hands for private profit, and be conducted recklessly at the expense of everybody else? Why shouldn’t banking be a public utility, operated for public good? Otherwise, it is only a matter of time before the next financial crisis, when, once again, the profits will be privatized and the losses socialized.

Reblogged this on Göerger.info und kommentierte:
This is a good argument for (at least temporary) socialist/public banking, for when the banks screw up and the economy tanks. I’m afraid the Bank of North Dakota (BND), though, while indeed with a public charter and legislated mission statement, is very strictly limited in the types of banking activity it may engage in (most loans are either municipal or under special legislative programs, typically dealing with agriculture or education), and so it is not really comparable to what we traditionally think of as a “bank”. You can’t walk in and open a checking account, for instance.

Indeed; I mean merely to point out (as a North Dakotan who frequently hears about my state’s alleged socialism) that the Bank of North Dakota is not a perfect model of a state-run bank, since it does not operate like the sort of bank most people think of when they think of a bank. It’s rather an awkward compromise between what the Non-Partisan League (NPL) led by Northern European immigrant farmers (tending socialist) wanted, and what the capitalist/bankers-led, conservative reactionary Independent Voters Association (IVA) which swept into power immediately following the NPL’s first takeover of the government, and which did not approve of the bank instituted during the NPL years—what they wanted. However, the bank’s populist policies proved too popular for the IVA, and so the populist social investment programs were allowed to continue, while private deposits were ended, indeed as you said, due to political pressure. Today support of the Bank’s populist programs is bipartisan, except among the Tea Party faction of the ND GOP.

The rest of your argument still stands perfectly; I just felt a need to clarify the role of the ND Bank, since North Dakota is to most people already a strange and exotic enough place, easily misunderstood.. 🙂

Déowyth, thank you for providing the background on the Bank of North Dakota. I’ve only been to North Dakota once, on a cross-country bus trip from Butte, Montana, to New York City. As someone who has always lived in a forested part of the country, I find the wide-open spaces of the Great Plains to be “exotic” in an interesting and fascinating way. I’d definitely like to visit the Theodore Roosevelt National Park if I ever get out there again.

[…] systemically-important banks is not a new idea. It was done very successfully, for example, in Norway and Sweden in the 1990s. But having the government clean up the books and then sell the bank back to the private sector is […]